Pricing power is not about raising prices

It is instead about the ability to increase value added per dollar spent by customers. By this definition, Costco has pricing power (fail me!). I used to think that raising prices equals pricing power, and in turn equates to a business with great industry economics. However, the more I study long-term, sustainable, value-adding companies, the more I realise the eventual demise of raising prices. Pricing power was one of my favourite mental models when categorising superiorities of businesses. Seeing how the world has changed, it is time, however, to practice some Darwinism and to destroy it.

I would argue that raising price on an identical product is today more of a drain on a firm's long-term sustainable advantage in most cases (careful not to apply ideas on a blanket basis). I see two issues. First, raising prices is a stab in the back to customers and incites animosity, and that violates what I call the Golden Rule of Business, which is to always treat customers like how you would like to be treated (to delight them of course!). Second, raising prices signals to the supply-side that an alternative solution is need – a lower cost one. When a business raises its prices, it is effectively plotting its own long-term demise by inviting competition.

Contrast this to companies that keep prices stagnant while continue to add value per dollar spent to their customers such as Costco and Amazon. To generate such cost advantages, they work hard on not a handful, but a million cost-saving initiatives. New entrants not only are discouraged to enter the market to compete on such a low margin, but find it impossible to replicate what the incumbents have done (try replicating a million cost saving initiatives while trying to build a brand and market your product!).

In the real world, we see a realisation of this by Apple (although they do add more value per dollar spent by innovating in their ecosystem). Notice that Apple's pricing philosophy is morphing towards one of affordability (I second that!). They don't need to do that to maintain profitability, but they are because of the realisation that the lower-spending market are the majority, and the larger the users in the Apple ecosystem, the higher the probability of a successful upsell and long-term reliance on the Apple ecosystem. With this new low-cost, bundling-of-services strategy, they will sacrifice short-term growth for long-term sustainability. Music to my ears!

This strategy is hard to implement. Raising prices is a very short-term hack to please investors and is often packaged to deceive investors of a long-term sustainable competitive advantage. Also, its unpopularity resides in the human tendency to demand immediate gratification. After all, getting rich slowly is often packaged as incompetence.